The Republic of the Marshall Islands (RMI) is a small, isolated and disperse country, highly dependent on external aid. GDP growth picked up in fiscal year (FY) 2012 (fiscal year, ending September 30) to 3.2 percent, lifted by a surge in fishery output and higher copra and coconut oil production. In FY2013, however, growth is expected to have slowed to 0.8 percent, dragged down by delays in the implementation of infrastructure projects. Meanwhile, inflation is estimated to have eased from 4.3 percent in FY2012 to 1.6 percent in FY2013, thanks to subdued global commodity prices. The fiscal balance slipped into deficit in FY2012, and is expected to stay at -0.8 percent of GDP in FY2013, driven by large transfers to poorly performing state-owned enterprises (SOEs). The current account deficit including official transfers remained elevated at 8.1 percent of GDP in FY2012, as high imports more than offset a pickup in exports and an increase in receipts from fishing license fees. Lending conditions have remained tight, with the banking sector providing only limited credit to businesses.

Although the RMI’s economic performance is expected to strengthen in FY2014, prospects over the medium to long-term are less sanguine. In FY2014, GDP growth is projected to rebound to 3.2 percent, driven by the resumption of Compact-funded infrastructure projects. In the longer term, however, growth is expected to slow to around 1½ percent, weighted down by the scheduled reduction in Compact grants and limited private sector growth. While the fiscal deficit is expected to decline in FY2014 thanks to one-off revenues, it is projected to widen again to around 2 percent of GDP in FY2015, and persist in the medium-term, driven by high subsidies to SOEs and increased expenditures for social security contributions for public sector employees from the upcoming pension reform.

Executive Directors noted that the Republic of the Marshall Islands’s recent output volatility and external imbalances reflect its narrow productive and export base, and vulnerability to external shocks. Medium-term growth prospects are constrained due to the unique challenges of small, remote island economies and the decline in Compact grants. Directors underscored the need for measures to promote fiscal and debt sustainability and foster private sector development and economic diversification.

Directors called for the implementation of a bold, but balanced fiscal consolidation strategy to secure long-term fiscal sustainability and build policy buffers. They welcomed the authorities’ plans to achieve a balanced budget in FY2014 and future surpluses through cuts in electricity and travel expenses and moderation of the public sector wage bill. They also encouraged swift approval and implementation of the pending tax reform, designed to promote efficiency and equity and boost tax compliance.

Directors stressed the need to address fiscal risks as part of a comprehensive adjustment strategy. They called for containment of subsidies to state-owned enterprises and their comprehensive restructuring with the assistance of the World Bank and Asian Development Bank. Directors also recommended parliamentary approval of the social security reform bill.

Directors welcomed the authorities’ initiatives to enhance public financial management and recommended the rapid approval and implementation of reforms to strengthen resource allocation and the medium-term budgeting framework. They looked forward to parliamentary approval of the Fiscal Responsibility and Debt Management Act.

While recognizing the challenges posed by RMI’s remoteness and small size, Directors underscored the importance of promoting diversified, inclusive growth through improvements to the regulatory framework and the business climate, including in the areas of investor protection and land reform. They recommended enhanced collaboration with development partners, the private sector and neighboring countries to upgrade both human capital and infrastructure.

Directors emphasized the need to strengthen the autonomy, capacity and supervisory authority of the Banking Commission over both bank and nonbank financial institutions, with a view to improving financial surveillance. They also called for efforts to address shortcomings in the Anti-Money Laundering/Combating the Financing of Terrorism (AML-CFT) framework.